The Markets
 
The numbers are coming in.
 
Publicly-traded companies report their earnings and sales numbers for the previous quarter in the current quarter. For example, fourth quarter’s sales and earnings are reported during the first quarter of the year, and first quarter’s sales and earnings will be reported during the second quarter, and so on.
 
Through last week, about one-fourth of the companies in the Standard & Poor (S&P)’s 500 Index had reported actual sales and earnings for the fourth quarter of 2017. As far as sales go, a record number – 81 percent – of companies sold more than expected during the fourth quarter. That was quite an improvement. FactSet reported:
 
“During the past year (four quarters), 64 percent of the companies in the S&P 500 have reported sales above the mean estimate on average. During the past five years (20 quarters), 56 percent of companies in the S&P 500 have reported sales above the mean estimate on average.”
 
The mean is the average of a group of numbers.
 
The money a company makes through sales is called revenue. For instance, if a lemonade stand sells 100 glasses of lemonade for $1 each, then the proprietors have earned $100. That is the stand’s ‘revenue.’ Of course, as every parent who has financed a lemonade stand knows, revenue doesn’t include the cost of the product. ‘Earnings’ are what the company has left after expenses – the bottom line. If every glass of lemonade cost 50 cents, then the stand’s earnings are $50.
 
Companies in the S&P 500 are doing pretty well on earnings, too. About three out of four companies have reported earnings higher than expected. Overall, earnings are 4.5 percent above estimates.
 
Through Friday, annual earnings growth for S&P 500 companies was 10.1 percent. It’s still early in the fourth quarter earnings season, but the data so far seem likely to confirm that 2017 was a bright, sun-shiny year for U.S. companies.

The Markets
 
Last week, the United States government might as well have hung a sign on the front door of the Capitol that read, “Gone negotiating. We’ll be back in…however long it takes.”
 
In 2013, the U.S. government closed for 16 days. About 850,000 federal workers were furloughed and 6.6 million workdays lost. The shutdown affected private companies that worked with the government, too, and the U.S. economy took a hit.
 
The prospect of kicking off 2018 with a government shutdown didn’t appear to concern investors too much. Barron’s reported the Dow Jones Industrial, Standard & Poor’s 500, and NASDAQ indices all finished the week higher.
 
The lack of response from investors isn’t all that surprising. Geopolitical events – from the Brexit vote to the U.S. bombing Syria to the North Korean nuclear escalation – have had little lasting effect on markets. The president of a financial research firm told The New York Times, “geopolitical events may be widely feared, and there will often be a knee-jerk market reaction when they’re unexpected, but seldom do they have a lasting impact. Underlying economic trends and monetary policy are far more important.”
 
That has been the case with previous U.S. government shutdowns. However, Investor’s Business Daily (IBD) wrote this time might be different:
 
“Government shutdowns always have been primarily over government spending, but this one will be mostly over an ideological divide on immigration, with budget issues playing a secondary role. That raises the risk that the partial government shutdown could be a long one and have more serious economic consequences than investors expect.”
 
IBD suggested it wouldn’t be long before the negative economic effects of dysfunctional government consume any economic gains delivered by tax reform. That may provide an incentive for our elected officials.

The Markets
 
Inflation, inflation, where’s the inflation?
 
The U.S. Federal Reserve has been raising interest rates in anticipation of higher inflation.
 
In its 2018 forecast, Goldman Sachs indicated it expected to see “a gradual increase in global core inflation, albeit to levels that are still below central bank targets in most places.”
 
At year-end 2017, Barron’s wrote:
 
“Economists have raised the specter of inflation for several years, only to be disproved time and again. There’s reason to believe, however, that 2018 will be different – that prices will finally rise in a more sustained pattern, forcing stock- and bond-market investors to react to a new trend. ‘An unanticipated acceleration in inflation is probably the biggest risk for markets in 2018,’ says Larry Hatheway, chief economist at GAM Investments…Economists like Hatheway aren’t expecting runaway inflation, as in the days of disco and leisure suits, when prices rose by double digits. They’re girding for an annual increase of 2 percent to 2.5 percent at the most.”
 
Last week, data released by the Department of Labor showed U.S. inflation, as measured by the Consumer Price Index, ticked higher (0.1 percent) during December. With food and energy excluded, the index was up 0.3 percent. Shelter, which reflects the cost of rent, rose the most (0.4 percent). The indices for medical care, new vehicles, used vehicles, and vehicle insurance all increased during December.
 
Some publications are predicting December’s uptick in inflation will lead to a March rate hike by the Federal Reserve. It’s difficult to say with certainty, however, until January’s inflation report is released on February 14.

The Markets
 
Whoosh! Bang! Flash! Fizz! Whistle!
 
U.S. stock markets delivered their own version of fireworks to celebrate the New Year. During the first week of 2018, the Dow Jones Industrial Average hit a new all-time high, moving above 25,000 for the first time ever. The NASDAQ Composite and Standard & Poor’s 500 Indices also rose to new highs.
 
2018 is off to an impressive start, but let’s pause for a moment and take a look back at 2017. It was a memorable year for global markets, but there are other reasons it was interesting, too. Here are the highlights of a few of The Economist’s most popular articles during the year:
 

• The world’s most valuable resource is no longer oil, but data (May 6). One-half of the most valuable companies in the world are American technology firms. Some, including The Economist, are concerned about tech companies’ market power and dominance of consumer data.

 

• The world’s most dangerous cities (March 31). Despite a declining murder rate, San Salvador remained the world’s most dangerous city, as measured by homicides per 100,000 during 2016 (the latest figure available). Acapulco ranked second. Several cities in the United States made the list including St. Louis, Baltimore, Detroit, and New Orleans.

 

• Governments may be big backers of the blockchain (June 1). Blockchain may seem complicated and difficult to understand, but it may become a part of everyday life. “…a blockchain expert at the Massachusetts Institute of Technology argues that governments will drive its adoption – an ironic twist for something that began as a libertarian counter model to centralized authority. Backers say it can be used for land registries, identity-management systems, health-care records, and even elections.”

 

• The death of the internal combustion engine (August 12). Rapidly changing battery technology and electric motors, in tandem with self-driving systems and ride sharing, may mark the beginning of the end for the internal combustion engine. It’s a change that is likely to disrupt markets and industries. The silver lining may prove to be less traffic and improved air quality.

 

• How to keep cool without costing the earth (February 11). Scientists at the University of Colorado in Boulder have “…invented a film that can cool buildings without the use of refrigerants and, remarkably, without drawing any power to do so. Better yet, this film can be made using standard roll-to-roll manufacturing methods at a cost of around 50 cents a square meter.”

 
 
There is a theme that appears to run through many of these articles. They explore new ways of doing things, such as cooling buildings and transporting people. The articles discuss the growing value of consumer data, which many people provide to companies for free, as well as technologies that may allow people to protect and monetize their data in the future (blockchain).
 
These new developments may be part of a process called creative destruction, which is a process of innovation that includes the introduction of new products and services that may eclipse existing ones. You don’t have to look far to find examples. Just think about the evolution of movie rentals, photography, or phones during the past couple decades.
 
Creative destruction was introduced in 1942 in Joseph Schumpeter’s book, Capitalism, Socialism and Democracy. He believed it was the essential fact about capitalism. More recently, MIT Professor Ricardo Caballero wrote, “Over the long run, the process of creative destruction accounts for over 50 percent of productivity growth.”
 
It seems, as Schumpeter suggested, we live in a gale of creative destruction.

The Markets
 
How good was 2017?
 
It was so good, the Standard & Poor’s (S&P) 500 Index finished in positive territory every month for the first time ever (on a total return basis), reported Barron’s. All major U.S. indices finished the year with double-digit gains.
 
As we enter 2018, keep an eye on investor sentiment. “History has shown us that the crowd can be right during trends, but it also tends to be wrong at extremes. This is why sentiment can be an important contrarian indicator, because if everyone who might become bearish has already sold, only buyers are left. The reverse also applies,” reported ValueWalk.
 
Toward the end of 2017, sentiment shifted, but not everyone shared the same outlook. Surveys and indices that track market indicators and institutional advice became less bullish, while newsletter writers and investors became more bullish.

• The CNN Fear & Greed Index dropped from Greedy territory into the Neutral range. The Index measures seven indicators including stock price strength and breadth, market momentum, high-yield bond demand, and market volatility to determine the emotion that may be driving markets.

 

• The TIM Group Market Sentiment fell from 47.3 percent to 43 percent, becoming more bearish. TIM tracks actionable ideas sent from the sell-side (e.g., investment and commercial banks; stock brokers; market makers) to buy-side clients (e.g., asset managers; institutional and retail investors). A score of zero is the most bearish and 100 is the most bullish.

 

• The AAII Investor Sentiment Survey indicated individual investors are becoming more bullish and less bearish. Some believe the survey is a contrarian indicator:

           
           Bullish sentiment was up 2.1 percent to 52.6 percent. The long-term average is              38.5 percent.
          Neutral sentiment was up 2.8 percent to 26.7 percent. The long-term average is             31.0 percent.
          Bearish sentiment was down 5 percent to 20.6 percent. The long-term average             is 30.5 percent. 
​
During 2017, U.S. markets appeared to be Teflon-coated. Geopolitical events, natural disasters, and other shocks had little impact on investor optimism or share prices, and expectations for volatility remained historically low. That may continue during 2018, or it may not.